Advantages and Disadvantages of Effective Budget Control

Advantages and Disadvantages of Effective Budget Control This paper will look at what is required of an effective budgetary control mechanism and try to assess the advantages and disadvantages of using a system imposed from above, or externally, over a decentralized system controlled by lower level management as task level. Using an empirical case study from the international banking sector, it will be shown that too much managerial autonomy can lead to disaster not just for the manager concerned but also for the whole organization. In contrast the role of the World Bank and International Monetary Fund in imposing nation-state loan budgets will be critiqued to highlight the potential flaws of centralizing and dominating budget control management. Effective budgetary controlHenderson (2003) notes that regardless of the situation or workplace, in order to be effective it is crucial that budgetary control systems: Account for money received and spent Make sure that the organizations financial policies are adhered to Ensure that money is not wasted Assist managers to run, and develop, services or departments These controls have developed from the need to account for large sums of money but are equally applicable to any budgetary situation. However, from a managerial perspective they have often been criticised for being insensitive and restrictive at the lower levels of management. As the number of stakeholders increases so does the need to be fully accountable and therefore more controls are also needed. This is particularly noticeable in the public sector National Health Service. Here lower level management are extremely subservient to imposed and tight budgeting restrictions from a distantly senior level. This is arguably a result of the need to satisfy a multitude of stakeholder interests and a concern that empowering lower management with the autonomy to control their own budgets would fail to include the number of interested parties from politicians to doctors and patients. With organisations as complex as the NHS whether public or private sector – It is safer and easier to p lan and control from above using imposed budget control methods. Politically imposed budgeting is preferably because senior managers, directors, or institutions who set the budgets are arguably best placed to recognise the wider implications of budgeting decisions but, according to Marginson (1999), financially imposed budget controls make sense too. Financial losses, which can occur for such damaging reasons as incompetence, error, negligence or fraud, are most likely to be minimised, or avoided altogether, by well constructed control systems. Imposed budgets benefit from the experience, acquired knowledge and full backing of senior management. They arguably encourage a sense of confidence in lower level management to do their job whilst reducing the massive levels of stress that come with having to create and manage your own budget. Another advantage of imposed budgeting is that it encourages regular monitoring, reporting, progress reports and ultimately improvements in the budgetary system. This enables problems to be uncovered and dealt with quickly and efficiently. Henderson (2003) states that it is advantageous to review arrangements occasionally. Even if procedures within your work area operate well, you should ensure that the budgetary responsibilities of staff at all levels are clear and understood by everyone. It would be unfortunate if problems arise because people do not know the extent or limit of their responsibilities (p33). Autonomous managers are arguably less likely to self-review their processes if they are deemed to be working well. Whereas senior management may be able to employ the use of an external or dedicated process-auditing team, lower level management are unlikely to have the resources or inclination to do the same especially if a process is deemed to be largely successful and given that any negative results will reflect directly and negatively on their managerial budgeting ability. There are further problems with lower level management dictating their own budget. As a budget manager, you are in charge of producing an annual cash flow forecast detailing accurately all of your income and expenditures. Budget managers are also expected to collect a range of information throughout each year, both financial and non-financial, to supplement their cash flow predictions and help better manage their finances. Finally they are then expected to critically compare the planned figures and the actual revenues and expenditures that occurred and act to ensure that the inflows and outflows of cash are within budget limits. In short, managers who are given control over their own budgets are required to be financially adept. Often, even if the manager is financially confident, proof of budgetary ability will only be learned from success or failure by which time it may be too late to rectify any problems. Marginson (1999) suggests that the concept of self-managing a budget at all levels through an organization is essentially flawed. If a manager has responsibility for a budget they he argues should not be expected to regulate and monitor is on their own. Ideally a system would be in place to bring any relevant or potentially important information to the managers attention. The flaw of any budgeting system that encourages managerial autonomy is that, eventually, in the case of poor performance a reporting system will eventually alert senior management to the crisis. Inevitably, senior manage will then try to rectify the situation costing time, resources and money. This often lengthy process would almost certainly be entirely avoided if senior management imposed budgetary control measures tightly from the top. A potential hazard in using imposed budgetary controls Imposing financial authority from the top-down may be one method of ensuring that the commands of senior management (or external bodies such a the Government) are carried out but this strict system of financial control is not necessarily the most productive method of financial management. The most commonly cited problem with a top-down method of strict budgetary control is the message that it permeates down the hierarchy. This invariably is translated as a lack of trust in the ability of lower-level and middle-management from those above them. As Benston (1963) explains: Decentralization contributes to effective motivation. The firm’s accounting system that facilitates decentralization hence has an indirect but important impact on motivation. The direct use of accounting reports, such as budgets, for motivation can result in reduced performance, if the budget is imposed on the department manager. (p347) The financial advantages of imposing budgetary control – such as less risk of money being wasted, tighter adherence to company financial polity etc are potentially offset by the negative effects on motivation (and therefore productivity and profitability) such a gesture could make.According to Petrova (2004), autonomy and motivation are commonly considered to be extremely closely associated to one another. Given the value of a motivated workforce, the use of imposed budgets could be limiting the success of the business as well as its employees. Case Study:  Too much managerial autonomy – Nick Leeson and banking crises Over the last two decades crises the banking worldwide and the subsequent global financial instability they have invariably caused have occurred with alarming regularity and always at a huge, often crippling, cost. According to estimates by the International Monetary Fund, more than a dozen banking crises in the past 15 years have cost the countries afflicted 10% or more of their gross domestic product (Economist, 2003). Although the majority of banking collapses seem to occur in the less developed and therefore poorer nations of the world, rich countries are also susceptible, as Japan demonstrated before the world in the 1990s. The blame is frequently – and correctly – laid on macroeconomic policy: an unsustainable exchange rate has no doubt often exacerbated problems but it is poor budgetary control that has been at the root of the majority of banking crises in recent times.. It is not just the banks who are to blame for this. Imposed budgets do not necessarily have to come from within the organisation. Bank regulators, too, should have done, and should do, more to help avoid these crises. The Basel Accord is the main external control that is used to protect the financial safety of banks. The Accord established a set of international rules that limit banks exposure to risk by requiring that their capital must at least equal a minimum proportion of their assets (Economist, 2003). This proportion is weighted by a calculated risk based on the circumstances of each individual bank. The Basel Accord is effectively the banking industries version of imposed budgeting. The external regulator oversees the business of the banks to ensure that they do not assume too much autonomy. (Economist, 2003) The case of Nick Leeson and the collapse of Barings Banks provides a hugely unlikely yet extremely note-worthy case to act as a warning of what can happen to companies that do not impose strict financial controls on their management. As Van der Stede (2000) warns, this is especially pertinent for companies concerned with achieving tangible results as they are more likely to have managers with a stronger focus on business matters that affect the short-term results (p609) and are therefore more likely to take poorly calculated risks with company money. In the Leeson case the bank were found to be guilty of allowing an unprecedented degree of managerial influence in the trading budget. This eventually allowed just a single employee Leeson to accumulate debts of over  £1.3 billion and bankrupt one of the worlds oldest banks. In a fatal mistake, the bank allowed Leeson to remain Chief Trader while being responsible for settling his trades, a job that is usually split. This had made it much simpler for him to hide his losses. (BBC, 2002). If any case highlights the dangers of allowing managers unbridled participation in budgetary control, the Lesson case is it. Problems with imposed budgets a global political perspective. The World Bank and the International Monetary Fund control the flow of finances and effectively national budgets in every country across the globe. Their role is to promote stable growth in a bid to increase the wealth of citizens across the globe. However, as recently as April 2005, hundreds of members of parliaments around the world are calling on these two institutions lenders of billions of dollars every year, – to renege many of the numerous conditions they impose on borrowing countries in order to secure their loans. These conditions, they say, are eroding national sovereignty and impeding long-term economic planning necessary to achieve positive and sustained growth. Instead, global politicians, most vocally from the less developing countries who are the primary victims of the current restrictive loan scheme, are calling for the World Bank and IMF to let local legislators have the final say in domestic economic policies. Typical IMF conditions imposed on lending nations include devaluation of local currencies, deregulation of state-owned industry, tight public spending caps, liberalisation of trade and exchange controls, withdrawal of subsidies, and more protections for the private sector and multinational companies (Mekay, 2005). Beyond this critics argue that both institutions have been guilty of providing inaccurate and detrimental economic advice that has only helped to compound the economic rigidities created by the loans causing delayed debt relief, increased poverty and undermined democracy, prompting demonstrations and street protests in many countries (Mekay, 2005). According to the petition, in 2003, the former Soviet state of Georgia’s budget deficit exceeded its IMF-set limit. The Fund then asked Georgia to revise its budget for that year, but the parliament refused to pass it. Rather than accepting this decision, the IMF allowed its lending programme with Georgia to expire in retaliation. This led to threats from the World Bank that it, too, would pull the plug on existing projects. (Mekay, 2005) The IMF and World Bank reflect a system of imposed budgeting that is arguably more detrimental than it is effective. Imposed budgets must be careful to provide some degree of flexibility and maneuverability if they are not to cause resentment and productivity problems. This is particularly the case if budgets are being set and imposed from external sources. On a local or company scale there are further problems with the use of imposed budgeting in trying to link financial failures with those responsible for them. It is important to be able to link levels of activity, the consumption of resources and the achievement of targets with the managers primarily responsible for making decisions about these issues (Henderson, p33). If budgets are imposed from above, it is potentially difficult to identify the source of budgetary failure. If managers are autonomous, any budgetary failure is attributed directly to them. This arguably generates stricter budgetary discipline, responsibility and better management. Unless you have the authority to control financial resources, you cannot effectively manage the services for which you are responsible (Henderson, p23). Conclusion Henderson (2003) argued that successful budgetary control resulted in; being able to account for money received and spent, making sure that the organisations financial policies are adhered to, ensuring that money is not wasted, and assisted managers to run, and develop, services or departments. There is no single correct way of managing budgets but from the evidence presented above it is arguable that imposing a set of budget controls is a more effective method of safeguarding company finances. Certainly this method guarantees that company polices are adhered to and money is accounted and, if employees and managers are motivated, imposed budgets do not necessarily detract from department development or cause money to be wasted. It is the assumption that motivation is sapped by reducing autonomy that is the major criticism of imposed budgeting but this is little proof that this is the case. Petrova (2004) writes in her article on motivation and autonomy that motivated employees may gain more from autonomy but autonomy in itself is not a guaranteed method of increasing employee motivation. In addition, Petrova concludes that the likely benefits for increasing autonomy for already motivated employees are unlikely to be returned in financial gains but rather in changes in leadership styles and organizational structure. Given that the foremost concern of budgeting is to secure the financial future of the company, rejecting imposed budgeting on account of its effect on organizational structure and leadership style arguably inappropriate. 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